Whose risk?

William D. Cohan’s broadside [ht: ja] against Bernie Sanders hinges on a simple, but fundamentally wrong, argument: we all benefit from the risks taken by Wall Street.

Simply put, Wall Street’s purpose is to re-allocate capital from people who have it (savers) to those who want it (borrowers) and then use it to grow businesses that employ billions of people around the globe and help give them a modicum of wealth that they did not have before. One man’s speculation, in other words, is another man’s risk-taking. Without people willing to take those risks, and having the chance to reap their reward, there wouldn’t be an Apple, a Google, a Facebook, or countless other large corporations. The billions of people around the world who are employed by thriving companies would lose their jobs.

Clearly, Cohan doesn’t understand Wall Street (or, for that matter, the rest of the financial sector). It doesn’t collect capital from one group of savers and allocate it to another group of borrowers, which then creates jobs. Rather, it recycles the surplus created by people who work in order to allow those who appropriate the surplus to collect even more. In other words, Wall Street manages the surplus on behalf of a small group of wealthy individuals and large corporations. And it grows its own profits not as a reward for taking risks but by taking a cut of each and every financial transaction.

As we know, Wall Street does in fact take risks, as it did in the lead-up to the crash of 2007-08. But the risks were borne not by Wall Street, but by the rest of us—in the form of massive layoffs and foreclosures.

What about the other part of the argument, that Wall Street helps businesses grow?

As it turns out, Matthew C. Klein addressed this issue just about a year ago. His argument, in short, is that productivity growth in rich countries started slowing down around the same time that the financial sector’s share of economic activity started rising rapidly.

First, the high salaries commanded in the financial sector — much of which can be attributed to too-big-to-fail subsidies and other forms of rent extraction — make it harder for genuinely innovative firms to hire researchers and invest in new technologies.

Second, the growth of the financial sector has been concentrated in mortgage lending, which means that more lending usually just leads to more building. That’s a problem for aggregate productivity, since the construction industry is one of the few that has consistently gotten less productive over time.

In other words, as illustrated in the chart above, the growth rate in productivity was systematically faster when the finance sector was relatively smaller (from 1948 to 1975), and then when the finance sector got bigger, productivity growth got smaller (from 1976 to 2014).

The ultimate irony is that Cohan actually makes Sanders’s case for breaking up Too Big to Fail banks and reigning in Wall Street:

Sanders is right that Wall Street still needs reform. The Dodd-Frank regulations fail to measure up; Wall Street lobbyists and $1000-an-hour attorneys work away each day to gut the meager reforms signed into law by President Barack Obama in July 2010. It is also unconscionable that Wall Street’s compensation system continues to reward bankers, traders, and executives to take big risks with other people’s money in hopes of getting big year-end bonuses. Thanks to this system, which has been prevalent since the 1970s, when Wall Street transformed itself from a bunch of undercapitalized private partnerships (where those partners had serious capital at risk every day) to a group of behemoth public companies (where the risk is borne by creditors and shareholders while the rewards go to the employees), Wall Street has become ground zero for one financial crisis after another.